Even when homeowners are in decent financial shape and can continue making payments on their mortgages, sometimes, they may consider walking away from their mortgages because low property values have left them “underwater” – owing more on their mortgages than what their property is worth. However, while the decision to escape an underwater mortgage through strategic default can be beneficial, it comes with another group of possibly negative results that should be taken into consideration. Read on to find out what happens if you walk away from your mortgage.
1. Your Credit Score Will Suffer
For the next seven years, the foreclosure will damage your ability to borrow money or qualify for lines of credit. It will become nearly impossible to buy or lease a new car, for example. However, this may not be an issue if you are able to pay cash anyway. As virtually all vehicles depreciate in value before their loans are paid off, virtually all auto loans end up putting buyers in the same positions that underwater mortgages do anyway. Paying cash for any necessary big purchases in the near future will save you money. If you cannot afford to pay cash for a house to live in, realize that this may put you in rental housing for a while. (To learn how to improve your credit score after a foreclosure, see 7 Tips On Improving Your Credit Score.)
2. You Could Suffer Professional Consequences
In some fields, credit scores are carefully monitored. As a result, the credit problems that your strategic default will cause could keep you from getting a job or a promotion. Depending on your profession, this could negate any positive benefits resulting from your choice to walk away.
3. Your Credit Cards Could Be Affected
Before you choose to strategically default on your mortgage, make sure that you do not have a credit card with a balance through the same bank from which you received your mortgage loan. If you default on the mortgage loan, your bank may choose to raise the fees and interest rates on your credit card balance. To protect against this, before going through with strategic default, get an unaffiliated credit card and transfer the balance. (For more information on credit card balance transfers, see How To Get The Best Deal On A Credit Card Balance Transfer.)
4. You Could Be Sued
In some cases, lenders can resort to civil action to cover their losses. (Even when the home is sold in a foreclosure auction, the lender takes losses if the price paid for the house is less than the original mortgage loan amount.) Some states, such as California, are non-recourse states that do not allow lenders to sue borrowers in situations like this. Even when lenders can sue, though, they may just write the difference off as a loss on their tax returns to claim a deduction. However, remember that in some states, lenders can still sue for up to 15 years after the fact.
5. You Could Owe Taxes
If your lender forgives your debt, the IRS typically counts the amount of forgiven debt as taxable income. The Mortgage Forgiveness Debt Relief Act extends an exception to people who are forgiven of mortgage debt, but that act does not apply to debts forgiven after 2012. (To learn more about the Mortgage Forgiveness Debt Relief Act, see The Tax Implications Of The Mortgage Forgiveness Debt Relief Act.)
6. You May Go Through A Lot Of Trouble For Nothing
Just as real estate prices go down, they can go up as well. In fact, they normally do. Even if the real estate market is suffering from a downturn, that downturn is probably temporary. If you are almost finished paying off your mortgage, paying the rest of what you owe may be a loss in the short run, but the long-run effect may still be a profit. You should particularly bear this in mind if you like living where you are and originally intended to do so for some time to come.
7. You Could Lose Sleep
According to one MSN Money article, 81 percent of people polled in the United States feel that it is immoral to simply walk away from a mortgage when you can still make payments. If you feel this way, the fact that you end up beating yourself up about it for years to come – either because you feel you have done something immoral or because you feel like you have failed – may not be worth the money you save. In considering this aspect of the decision, though, remember that many of the loudest critics of strategic default on moral grounds are hypocrites: they are bankers and finance industry professionals who frequently engage in aggressive speculation and walk away from financial obligations whenever it is beneficial to do so.
If you feel that it is in your best interest to escape your current mortgage agreement, a strategic default may be the best option for you. However, in addition to considering the possible negative impacts, you should also consider the possible alternatives. For instance, in some cases, you may be able to resort to a short sale, a reverse mortgage or a loan renegotiation. These options often help borrowers to avoid or minimize the common negative effects of strategic default, but they require lender cooperation.